Human brain and decision-making factors behind investor choices

Human Brain and Decision-Making
Factors behind Investor Choices

We can point to some general practices that can help investors improve their investment decision making:


- Thinking more analytically when making important financial decisions.
 
- Being pro-active, curious and non-assumptive at all times and spending time to evaluate investments, possible risks and benefits.

- Continuously striving towards improving self-control and avoiding hastiness.

- Avoiding making any important investment decision while being in a passive state of mind.

- Creating a balance between being patient and being dynamic about investment choices.

 

We have also attached a summary:  BFM_Newsletter_08_2011.pdf.

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What just happened to the credit rating of the US?

Standard & Poor’s (S&P) lowered its long-term debt rating by one notch, from AAA to AA+, but left the short-term rating at A-1+. S&P left the sovereign debt rating on negative outlook. The move was expected. S&P had revised its outlook on the US to negative from stable back in April 2011. In July, it placed the rating on CreditWatch negative, indicating a near-term rating change was possible. The downgrade reflects the default risk associated with the US. The difference between a triple-A or double-A rated credit in terms of default is almost imperceptible.

Thru Monday, August 8, the equity markets had fallen 15% in the past two weeks, were down 12% for 2011 and were flat for the past 12 months. To put this in perspective, the markets decreased about 80% during the Great Depression, around 40% in 2001-2002, in 2008, and were down around 20% in one day in October 1987 or in two days at the beginning of the Great Depression in October 1929.

We take a long-term, academic and disciplined approach to investing and we try not to react emotionally to market swings, unlike many individual investors who tend to sell equities and lock in losses during down-turns.

The portfolios we recommend are well-diversified. For example, we recommend to invest in emerging markets funds which have been up 14% for the last 10 years on an annualized basis (vs. 1% for the S&P 500).

Although we closely monitor the markets, we are not market timers and market movements do not affect our strategic asset allocation.

Twice since 2000, the markets have experienced large movements (40+% decrease). These down-turns create significant opportunities to rebalance portfolios and buy equities at low cost.

On the positive side:

Corporate margins and balance sheets are in good shape.

Equities are not generally expensive compared to historic norms or compared to bonds.

The unemployment rate is slowly decreasing and is now at 9.1% vs. 9.8% in November 2010.

In the last 25 years there have been 11 country downgrades from AAA. In 10 such unhappy occurrences, the local 10-year government bond yield was lower one year after the credit action. The stock market results were somewhat more mixed but were generally positive – on average, the local index of the country downgraded was up nearly 17% a year later.

On the negative side:

Large Debt in US, EU and Japan.

The odds of a recession are increasing.

Leading indicators are no longer improving.

Growing concerns over higher tax rates, fiscal consolidation, and a potential default in Italy.

Real estate prices are not improving.

The unemployment rate is still high.

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We have discovered that the most valuable things we do for our clients is the selection of mutual funds, the construction of portfolios, and making sure they have enough asset as long as they live by focusing on asset allocation and diversification. If you have any ideas on how we might connect with people who could benefit our help, your advice would be a great help.

This newsletter was first published in August of 2011

http://bourbon-fm.com/file/BFM_Newsletter_08_2011_Brain_Decision_Making.pdf